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Introduction

In order for a company to qualify for EMI, it has to meet certain conditions. These are:

  • Independence
  • Having only qualifying subsidiaries
  • Gross assets
  • Number of employees, and
  • Trading activities.

Independence requirement

To be a qualifying company for EMI, a company must not be a 51% subsidiary. This means that more than 50% of its ordinary share capital must not be owned by another company or controlled by another company, or by another company and persons connected with it. Arrangements must not exist which could result in the company becoming a 51% subsidiary or otherwise being controlled, (Paragraph 9).

Control in this context means the power of one company to ensure that the affairs of another company whose shares are subject to EMI option are conducted in accordance with that company’s wishes. This may be through share ownership, voting power, or because of any powers conferred by Articles of Association or other document, (Sections 719 ITEPA 2003 and 995 ITA 2007).

Qualifying subsidiaries

A company that has one or more subsidiaries does not qualify for EMI unless each subsidiary is a qualifying subsidiary. A subsidiary means a company which the company controls, either on its own or together with any person connected with it. Subsidiary companies include dormant companies.

A subsidiary is only a qualifying subsidiary if the company whose shares are subject to EMI options holds, directly or indirectly, more than 50% of the share capital of the subsidiary.

No other person must be able to control the subsidiary, with control having the same meaning as it had for the independence requirement. There must be no arrangements in existence by virtue of which any person could obtain control of it.

If a subsidiary is being wound up, disposed of or is in administration or receivership, the company will not be treated as failing the qualifying subsidiaries test as a result of something that is done as a consequence of the winding up, disposal or going into administration or receivership. This only applies if the transaction is done for commercial purposes and is not part of a scheme or arrangement the purpose (or one of the main purposes) of which is to avoid tax.

Qualifying property managing subsidiaries

A company will not qualify if it has a property managing subsidiary which is not a 90% subsidiary of the company. A property managing company is one whose business consists wholly or mainly in the holding or managing of land, buildings or interests in land.

To be a qualifying property managing subsidiary, the company whose shares are subject to EMI options must:

  • possess directly at least 90% of the issued share capital and the voting power in the subsidiary, or
  • be entitled to receive at least 90% of the assets of the subsidiary, in the event of a winding up or in any other circumstances, if they were all distributed,
  • be entitled to at least 90% of profits of the subsidiary available for distribution to shareholders.

No other person must be able to control the subsidiary, with control having the same meaning as it has for the independence requirement. There must be no arrangements in existence by virtue of which any person could obtain control of it.

If a subsidiary is being wound up, disposed of or is in administration or receivership, the company will not be treated as failing the qualifying subsidiaries test as a result of something that is done as a consequence of the winding up, disposal or going into administration or receivership. This only applies if the transaction is done for commercial purposes and is not part of a scheme or arrangement the purpose (or one of the main purposes) of which is to avoid tax.

Gross assets requirements

The value of the company’s gross assets must not exceed £30 million at the date the EMI option is granted. If the company is a member of a group of companies, the limits are applied to the gross assets of the group as a whole.

Number of employees requirement

From 21 July 2008, a qualifying company must have fewer than 250 full-time equivalent employees at the date on which a qualifying EMI option is granted. This requirement applies to employees of the company and all its qualifying subsidiaries, whether or not the employees are based in the UK. Directors are counted as employees for the purpose of this test, but students on vocational training, and employees on maternity or paternity leave at the time an option is granted are not to be counted. Apprentices are also excluded from the definition of employees for this test, if in accordance with general legislation on employment law they are not regarded as employees.

A full-time employee is someone whose standard working week (excluding lunch breaks and overtime) is at least 35 hours. Any employee who worked longer than those hours would still only count as one full-time employee. Where there are part-time employees their full-time equivalence can be calculated on any “just and reasonable” basis. For example, someone working 21 hours a week would be expected to count as 60% of a full-time employee. Someone working ‘one week on, one week off’ would count as 50%, while the proportion of an employee working in term times only would depend on the length of those terms in relation to the year as a whole.

If a qualifying EMI option was granted before 21 July 2008 by a company with more than 250 full-time equivalent employees, the option remains a qualifying option, but the company cannot grant any more qualifying EMI options unless the number of full-time equivalent employees falls below 250.

Trading activities & UK permanent establishment requirement

For a company to be a qualifying company for EMI purposes, a company must carry on a qualifying trade on a commercial, profit making basis, which does not, to any substantial extent, include certain excluded trading activities. Until 15 December 2010 the qualifying trade must have been carried on wholly or mainly in the UK.

With effect from 16 December 2010 the requirement became that the qualifying company must have a permanent establishment in the United Kingdom. If the company is a parent company, at least one member of the group must meet all other trading activity requirements, whilst having a permanent establishment in the United Kingdom.

For a company to be considered to have a permanent establishment in the United Kingdom, either of the following must apply:

  • it has a fixed place of business there through which the company’s business is wholly or partly carried on; or
  • an agent acting on behalf of the company has and habitually exercises there authority to enter into contracts on behalf of the company.

The legislation lists a number of examples of fixed places of business, including:

  • a place of management;
  • a branch;
  • an office;
  • a factory,
  • a workshop,
  • an installation or structure for the exploration of natural resources,
  • a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; and
  • a building site or construction or installation project.

The type of business will determine the type and nature of the premises or facilities required. However, these would qualify as a permanent establishment only if in relation to the business as a whole, the activities carried on there are not of a preparatory or auxiliary character.

The legislation also allows a company to be treated as having a permanent establishment in the UK where an agent has and exercises authority in the UK to enter into contracts on behalf of the company. This test is offered as an alternative to the “fixed place of business” test and the company need only meet one of the tests to qualify.

The agent must have and must repeatedly use the authority to enter into contracts on behalf of the company or which are otherwise binding on the company. The contracts in question must relate to the substantive business of the company and not merely to matters which would be considered preparatory or auxiliary.

If a company is not a member of a group it must exist (apart from any incidental purposes) wholly for the purpose of carrying on one or more qualifying trades. It must be either carrying on a qualifying trade or preparing to carry on a qualifying trade which it must begin within two years of the options being granted. If the trade does not begin within this time period, this is a disqualifying event.

Carrying on research and development from which a qualifying trade will be derived, or benefit, is treated as carrying on a qualifying trade, but preparing to carry on research and development, does not count as preparing to carry on a qualifying trade. Research and development means activities that are treated as research and development in accordance with normal accounting practice, but this excludes oil and gas exploration or appraisal.

When considering whether the trade is a qualifying trade, the holding and managing of property used by the company, and holding shares to which investment relief is attributable, if this is not a substantial part of the company’s business, are disregarded.

Trading activities requirement for a parent company

Where the company is the parent of a group, the business of the group must not consist to any substantial extent of carrying on activities other than qualifying activities. At least one company in the group must meet the same conditions as those described for a single company. The business of the group means all the activities of the companies in the group taken together.

In determining whether a group company exists for the required purpose, the following intra-group activities are disregarded:

  • holding shares in or securities of, or making loans to, another company in the group (Paragraph 14(3)(a)),
  • holding and managing property used for a qualifying trade carried on by a group company (Paragraph 14(3)(b)), and
  • incidental activities of a company which meets the trading activities requirement for a single company (Paragraph 14(3)(c)).

Excluded activities

A trade will not qualify if one or more excluded activities together amount to a substantial part of it. Excluded trading activities (Paragraphs 16–23) are:

  • dealing in land, commodities or futures, or shares, securities or other financial instruments,
  • dealing in goods, otherwise than in the course of an ordinary trade of wholesale or retail distribution,
  • banking, insurance, money-lending, debt-factoring, hire purchase financing or other financial activities,
  • leasing (including letting ships on charter, or other assets on hire),
  • receiving royalties or other licence fees,
  • providing legal or accountancy services,
  • property development,
  • farming or market gardening,
  • holding, managing or occupying woodlands, any other forestry activities or timber production,
  • shipbuilding, coal and steel production,
  • operating or managing hotels or comparable establishments or managing property used as a hotel or comparable establishment,
  • operating or managing nursing homes or residential care homes, or managing property used as a nursing home or residential care home, and
  • providing services or facilities for another business.

Dealing in goods otherwise than in ordinary wholesale and retail distribution

An ordinary trade of wholesale and retail distribution is outside the exclusion of dealing in goods. In determining whether a trade is an ordinary trade of wholesale or retail distribution the following features must be considered.

Features that may indicate that the trade is normal wholesale or retail distribution are:

  • the vendor buys goods in larger quantities than he sells them,
  • the goods are bought and sold in different markets,
  • the vendor employs staff and incurs expenses in addition to the cost of the goods and, if appropriate, remuneration.

Features that may indicate that the trade is not normal wholesale or retail distribution are:

  • there are purchases or sales from people connected to the vendor,
  • purchases are matched with forward sales or vice versa,
  • the goods are held by the vendor for longer than is usual for goods of the kind in question,
  • the trade is carried on at a place or places not commonly used for such a trade,
  • the vendor does not take physical possession of the goods.

In the vast majority of cases, it is clear whether a trade is an ordinary wholesale or retail trade of distribution without referring to the list. No method of evaluating the listed features is prescribed. Not all the listed features will always be relevant, and the presence or absence of a particular feature will not be conclusive.

In addition to this list of features, the legislation provides that in one particular set of circumstances a trade is not an ordinary trade of wholesale or retail distribution. Where a trade consists ‘to a substantial extent’ of dealing in goods of a kind which are either collected or held as an investment (for example, fine wines, antiques or vintage cars), and a ‘substantial proportion’ of the goods are held for a period which is significantly longer than the period for which a vendor would reasonably be expected to hold them while endeavouring to dispose of them at their market value then it is not an ordinary trade of wholesale or retail distribution. Therefore if a substantial proportion of the ‘investment’ goods are not being actively marketed at a realistic price, the trade is disqualified even if a ‘normal’ trader in that field would be holding such stock for maturity and actively marketing it.

Leasing of certain ships

Leasing, including letting ships on charter or other assets on hire, is an excluded trade for EMI, with the exception of the leasing of certain ships.

The leasing or chartering of ships is a qualifying trade if all the following conditions are satisfied:

  • the ship let on charter by the company is beneficially owned by the company,
  • every ship beneficially owned by the company is registered in the UK,
  • the company is solely responsible for arranging the marketing of the service of its ships,
  • every letting of ships by the company is for a period of 12 months or less and there is no provision to extend this other than by the choice of the person chartering the ship,
  • every letting is an arm’s length transaction between the company and an unconnected person, except where the letting is between the company and a qualifying subsidiary or between 2 qualifying subsidiaries, and
  • the terms of every letting make it clear that, throughout the period of the charter, the company is responsible for taking all management decisions relating to the ship and paying all expenses in connection with it, other than those incidental to a particular voyage, and no arrangements exist by which another person can be appointed to take over these responsibilities.

For these purposes, ships do not include offshore installations (such as oil rigs) or pleasure craft. Pleasure craft means any ship of a kind primarily used for sport or recreation.

Receipt of royalties or licence fees

Receiving royalties or licence fees is an excluded trade, but that exclusion is waived in certain circumstances as shown below.

The waiver applies where the royalties or licence fees are attributable to the exploitation of certain assets described as ‘relevant intangible assets’. Where some of the royalties or licence fees are attributable to this and some are not, the latter can be ignored if they do not amount to a substantial part of the total in terms of their value.

An ‘intangible asset’ for this purpose is anything that could be treated as such under normal UK accounting practice, which is set out in Financial Reporting Standards 12. This covers all intellectual property as defined in the legislation, and also industrial information and techniques.

The definition of ‘relevant intangible asset’ was widened with effect from 6 April 2007. It is now defined as an asset created by the company issuing the EMI options, or by a company that was a qualifying subsidiary of the company issuing EMI options for the whole of the period during which it created the asset. Prior to 6 April 2007, the legislation was more restrictive, with the unintended consequence that when a company transferred assets to a subsidiary, this could have been a disqualifying event.

Property development

Property development is defined as the development of land with the object of realising a gain from the disposal of the land when developed. It includes redevelopment.

Shipbuilding, coal and steel production

Shipbuilding, producing coal and producing steel became excluded activities from 21 July 2008. Options granted before that date by companies that engaged in these activities were unaffected by the change.

Shipbuilding means the building of self propelled seagoing commercial vehicles. To meet that definition vessels have to have permanent propulsion and “all the characteristics of self navigation on the high seas”.

Shipbuilding companies which can qualify for EMI:

Vessels of less than 100 gross tonnes (or tugs of less than 365KW) are not covered by this exclusion. And because they are not seagoing vessels, neither are vessels built for use on inland waterways. Military vessels and large private yachts are also not excluded as they are not commercial vessels.

Ship repairing or conversion is not regarded as shipbuilding, so those activities are not excluded.

Producing coal includes the production, winning and extraction of it as well as consequential activities such as washing, sizing, sorting and transporting coal to the point of delivery. The transport or warehousing of steel and the manufacture of finished products from steel are not excluded activities.

Hotels and comparable establishments

Activities consisting of the operation or management of hotels are excluded. This goes wider than ownership of a hotel, but applies only where the company occupies the premises or has some legal interest in them.

A hotel is defined in the Hotel Proprietors Act, 1956 as ‘an establishment held out by the proprietor as offering food, drink and, if so required, sleeping accommodation, without special contract, to any traveller presenting himself who appears able and willing to pay a reasonable sum for the services and facilities provided and who is in a fit state to be received’.

The exclusion also applies to any establishment, such as a guest house or hostel, where the main purpose is the provision of overnight accommodation, with or without catering services. It does not cover institutions such as prisons and boarding schools, where, although overnight accommodation is provided, the main purpose is quite different.

Nursing homes and residential care homes

Activities consisting of the operation or management of nursing homes and residential care homes are excluded. This goes wider than ownership of such homes, but applies only where the company occupies the premises or has some legal interest in them.

A nursing home means an establishment that exists wholly or mainly for the provision of nursing care for people suffering from sickness, injury or infirmity or for women who are pregnant or have given birth.

A residential care home means an establishment that exists wholly or mainly for the provision of residential accommodation, board and personal care for people who are in need of personal care because of old age, mental or physical disability, past or present dependence on alcohol or drugs, past illness or past or present mental disorder.

Provision of facilities for another business

Providing services or facilities for any business carried on by another person (other than the parent of the company) is an excluded activity where that other business consists to a substantial extent of any excluded activities, and a controlling interest in that other business is held by a person who also has a controlling interest in the business carried on by the company.

A person has a controlling interest in a business if:

(a) in the case of a business carried on by a company:

  • he controls the company, or
  • the company is a close company and he (or an associate of his) is both a director of it and the beneficial owner of, or able directly or through the medium of other companies (or by any other indirect means) to control, more than 30% of its ordinary share capital, or
  • he owns at least one-half of the business by reference to any of the tests of ownership set out in Section 942 of CTA 2010.

(b) in any other case, he is entitled to not less than half of the assets used for, or the income arising from, the business.

For the purposes of (a) and (b) above, the rights or powers of any person’s associate count as his rights and powers.

For the purposes of (a) above, ‘control’ has the meaning given to it by Sections 450 and 451 of CTA 2010, (Paragraph 23).